ETF Trends CEO Tom Lydon discussed the Principal U.S. Mega-Cap Multi-Factor Index ETF (USMC) on this week’s “ETF of the Week” podcast with Chuck Jaffe on the MoneyLife Show.

USMC is a strategic beta solution that seeks enhanced stability with exposure to the largest companies in the United States. The Principal U.S. Mega-Cap Multi-Factor Index ETF goes beyond traditional cap-weighted approaches to provide market-like returns with reduced volatility.

With all that’s going on, Lydon suggests considering a de-risking ETF strategy to participate in the broad equity market, reducing any further potential drawdowns.

A bear market hurts, but it doesn’t last forever. Historically, a bear market where the S&P 500 declined 20% more would experience a mean duration of 14.4 months. The market experiences a mean maximum drawdown of 36.7% in the selling periods. So far, the S&P 500 has currently declined about 25% from its February 19 high. So, after the fall, now what?

As we return to equities markets, investors should do their due diligence for U.S. large-cap if one is to seek risk mitigation since the traditional market capitalization-weighted fund strategies may come with unintended risks. Traditional market cap-weighted indices lean toward the largest companies that have done the best during the decade-long bull market. Consequently, these market-cap weighted indices are top-heavy and are likely overweight the most overvalued companies.

Better Manage Risk Exposures

Alternative indexing methodology or smart beta ETFs could help diminish this weight-risk. To better manage risk exposures, investors may consider a smart beta or customized index-based ETF strategy that adheres to a strict rule-following indexing methodology aimed at limiting downside risks while providing upside potential.

For example, the USMC’s underlying index, Nasdaq US Mega Cap Select Leaders Index, is comprised of companies with the largest market capitalization taken from the Nasdaq U.S. 500 Large Cap Index but with a twist. USMC is a lower risk-oriented ETF, an increasingly popular strategy within the broader smart beta universe.

The fund’s underlying index utilizes a modified equal-dollar weighting methodology where securities in the top 10% of aggregate market capitalization are weighted by market cap. Securities of the remaining 90% companies are equally weighted, and, in some instances, weights are adjusted to emphasize stocks with lower historical volatility and de-emphasize stocks with higher historical volatility.

The result is a portfolio that does not mirror your typical “low-vol” investment approach. For example, when compared to more popularly tracked indices like the MSCI USA Minimum Volatility Index (USMV) or the S&P 500 Low Volatility Index (SPLV), USMC’s underlying Nasdaq US Mega Cap Select Leaders Index exhibits a more significant tilt toward large-cap versus the benchmark S&P 500 Index.

This makes sense since USMC is focused on the largest names. Additionally, USMC’s Nasdaq US Mega Cap Select Leaders Index exhibits lower volatility, slightly higher momentum and higher quality, compared to the S&P 500.

Related: A Way to Better Manage Equity Risk with a Low-Volatility ETF 

Due to its indexing methodology, the Nasdaq US Mega Cap Select Leaders Index takes on greater underweight to sectors like financial services, materials, real estate, utilities, and industrials, compared to the more widely observed MSCI USA Minimum Volatility Index (USMV) or the S&P 500 Low Volatility Index (SPLV). On the other hand, USMC includes a greater overweight toward sectors like healthcare, consumer defensive, communication services, and technology.

As far as its current performance, there have been lower drawdowns in USMC. The fund is -13.3% over the past 1-month vs SPLV at -19.0%, and USMV at -16.4%. The Nasdaq US Mega Cap Select Leaders Index indexing methodology has helped USMC limit drawdowns and participates in market rallies, producing improved risk-adjusted returns over the S&P 500 in the long run.

Listen To Tom Lydon Talk USMC:


For more podcast episodes featuring Tom Lydon, visit our podcasts category.